Countering Disruptions in Iranian Oil Supply

6 Reasons Why the Obama Administration’s Iran Strategy Is the Best Way Forward

Posted on June 11, 2012, 9:00 am

This is the third in a six-part series explaining why the United States should continue to pursue an integrated strategy of diplomacy and tough economic sanctions to prevent Iran from obtaining nuclear weapons. It builds on the recent Center for American Progress report, “Strengthening America’s Options on Iran.” Each piece in the series looks at reasons why diplomacy is an effective approach to achieving this end.

This week we look at what actions the United States and its allies could take to counter disruptions in Iranian oil supply or a closing of the Strait of Hormuz by Iran in response to sanctions.

One critical piece in the Obama administration’s strategy to hinder Iran’s nuclear ambitions is to cut off the country’s funding supply, namely oil exports. More than half of the Iranian government’s revenue comes from oil exports, which make import reductions by key Iranian crude oil consumers such as Japan and India particularly devastating to the Iranian economy.

July 1 looms large on the international community’s calendar, as it’s the day a full embargo of Iranian crude oil by the European Union is set to go into effect. While further reductions in Iranian oil exports serve the international community’s interest in hindering Iran’s nuclear ambitions, the lost Iranian oil must be replaced by another source.

In the event that Iranian oil shipments are not available, what capacity exists to boost oil deliveries to countries now dependent upon Iranian oil supply?

U.S. Energy Secretary Steven Chu believes there is enough capacity in global oil markets to make up for reductions in Iranian exports, despite the Energy Information Administration’s determination that spare oil production capacity “is currently quite modest relative to historical levels.” Secretary Chu’s claims have been buoyed by the recovery of Libyan oil production and a 20% increase in Iraqi oil exports this year to 2.5 million barrels per day. The International Energy Agency estimates that Iraqi oil production can reasonably be expected to double by 2015, which would also serve to offset losses of Iranian oil.

The International Energy Agency also believes that despite producing oil at the highest rate in 30 years, Saudi Arabia still has 2 million barrels per day of spare capacity—well above the expected 500,000-barrel-per-day shortfall from Iran due to sanctions. Yet the International Energy Agency also expects the narrowing cushion against other shocks to increase the risk premium and thus the overall price for oil at the same time. The Economist Intelligence Unit recently issued similar though slightly higher numbers for current Saudi spare capacity—about 2.5 million barrels per day.

In its latest analysis, however, the International Energy Agency notes that spare oil-production capacity has tightened, reaching a 30-year high—despite Saudi, Iraqi, and Libyan production increases—due to unexpected supply disruptions in South Sudan, Yemen, Syria, and the North Sea. While the agency expects a “bumpy ride in the months ahead,” it predicts that production increases in Angola, Nigeria, Libya, and Iraq will later this year offset the current disruptions.

Additionally, a G-8 deal reached last month—in which the G-8 countries agreed to release oil from their strategic reserves to counter any supply disruptions—could further ease price disruptions. This type of coordinated response by the international community has been a key pillar of the Obama administration’s approach to Iran and the main reason for the approach’s success.

Should the Strait of Hormuz be forcibly closed by Iran, however, the ability of the major energy exporters in the Persian Gulf to offset Iranian oil lost to sanctions will be severely curtailed.

Iraq has extremely limited options for alternative oil-export routes. The closure of an internal north-south pipeline prevents Iraq from exporting fully via Turkey, while alternative pipelines to Saudi Arabia and Lebanon have been deactivated.

Saudi Arabia currently exports three-quarters of its oil from the Ras Tanura terminal in the Gulf, where it must pass through the Strait of Hormuz, and one-quarter from the Yanbu terminal on the Red Sea. The Yanbu terminal has a maximum capacity of 4.5 million barrels per day, and the east-west pipeline from Saudi oil fields near the Gulf to Yanbu has a maximum capacity of 5 million barrels per day.

Saudi Arabian oil output has increased to 10.1 million barrels per day—its highest rate in decades—in response to Iranian declines. But Saudi oil exports would likely decrease dramatically in the event that Iran closes the Strait of Hormuz, something it has threatened in the past.

Despite these threats to close the strait by force, however, it currently remains open to military and commercial traffic. The Strait of Hormuz is a critical chokepoint for global energy supplies, with the Energy Information Administration estimating that 20 percent of all oil traded worldwide—almost 17 million barrels per day—flowed through the waterway in 2011. More than 85 percent of oil exported through the strait is destined for Asian markets, with Japan, India, South Korea, and China being the largest buyers.

In 2011 an average of 14 tankers filled with crude oil passed through the strait every day, with a similar number entering the Persian Gulf to take on oil. According to the Energy Information Administration, “closure of the Strait of Hormuz would require the use of longer alternate routes at increased transportation costs.”

A 2008 analysis published in International Security assessed that Iranian military ships and submarines could lay nearly 700 mines in the Strait of Hormuz without utilizing specialized mining vessels or helicopters, which would be more easily detected. Given the volume of shipping and space restrictions in the strait, the author estimates that this number would be sufficient to deter shipping and would close the strait. Projecting from U.S. mine clearance efforts against Iraq in 1991 and 2003, the analysis suggests that clearing the Strait of Hormuz of all Iranian mines with 15 mine-countermeasure ships could take between 35.5 and 39 days if no Iranian opposition were encountered. Clearing a simple safe route through the minefield could take between three and four days.

These figures are likely underestimates given the greater area and superior mines
that would be involved in clearing the strait, as well as the prospect that clearing
mines from the strait would involve an air campaign to neutralize Iranian antishipping and antiair capabilities near it. Closing the strait also cuts off incoming shipping, and it would prevent Iranian oil from leaving the Persian Gulf.

Chairman of the Joint Chiefs of Staff Gen. Martin Dempsey acknowledges that Iran could “for a period of time” close the Strait of Hormuz but adds that the United States has the capabilities necessary to reopen it. In the event that Iran attempted to forcibly close the strait, the United States could probably count on the support of Great Britain and France, whose ships accompanied the U.S.S. Abraham Lincoln when it transited the strait following recent Iranian threats against U.S. military ships using it.

The next round of negotiations between Iran and the permanent five members of the U.N. Security Council—the United States, the United Kingdom, France, China, and Russia—plus Germany (also known as the P5+1) will take place June 18 in Moscow. It will likely be the last round of talks before the EU oil embargo goes into effect on July 1. U.S., European, and Chinese negotiators should be aware of both the immense pressure the July 1 embargo will put on the Iranian economy, and what capabilities currently exist to offset the loss of Iranian oil.

Next week we examine Israel’s capability to “go it alone” in any military action against Iran, and the existing links between Iran and Middle East terrorist groups.